A general shock pervaded the mortgage-backed market and dealer screens remained virtually empty last Wednesday after the Federal Reserve cut interest rates by 50 basis points, sparking the possibility that the current Refi "pickup" might transform into a full-blown Refi wave.

MBS analysts were almost unanimous that the rate cut is a very good thing for mortgages, mainly because the "carry" - the difference in yield between bond yields and borrowing costs - is increasing, meaning that premium bonds would benefit the most. The improvement in carry is mostly due to a decline in funding costs spurred on by the interest rate cuts.

"This is a very big move, early in the year, and the Fed is still meeting on Jan. 31," said David Montano, director of MBS research at Credit Suisse First Boston. "People were expecting an easing of 75 basis points for the first two quarters, and we've already had a 50 basis point cut in the first week of 2001. This is very, very good news, especially for higher coupons."

Montano pointed out that the rate cut is especially a benefit for banks, which had been out of the market because of high funding costs. Now they will be able to continue buying mortgages as the Treasury curve steepens.

The rate on the 10-year Treasury - which most mortgages are pegged to - fell as low as 4.94% in the early afternoon following the Fed's announcement. Mortgage-backed securities prices were also falling and were down slightly on the day.

It had been anticipated that the Fed might cut rates before its Federal Open Market Committee meeting later this month, but not this early.

Recently, refis were running at 44% of all new applications, according to the Mortgage Bankers Association of America. With the rate cut, refis are certain to increase.

"There will be a significant pickup in refis starting next week," said Art Frank, the head of MBS research at Nomura Securities. "But the rate cut has caused a roaring stock market, so money has left the bond market to go to stocks, and the long end of the Treasury curve is weak. But the steepening of the curve is definitely good for premiums."

Freddie Mac's report last week that mortgage rates again declined put refi concerns on alert and fueled more down-in-coupon moves toward the end of the week. The 30-year fixed mortgage rate declined six basis points to 7.07%.

With some of the dust settling following last week's surprising rate cut, predictions are the Fed still will have to make substantial rate cuts going forward.

Pimco's Bill Gross says he believes the Fed is likely to cut rates another 50 to 100 basis points over the next three to six months. Some analysts also predict yields will be back to levels just prior to the rate cut by the end of the month. This keeps prepayment risk in mortgages fairly high.

Currently, more than 60% of the 1999/2000 universe is at risk, which covers 7.5s, 8s and high WAC 7s. Mortgage rates just have to move less than 20 basis points lower and 80% of the 1999/2000 origination universe will be exposed and 50% of the entire mortgage universe, according to Bear Stearns.

While prepayment risk is priced in the market, there is still a reluctance by many investors into moving into premium coupons until better information is available quantifying that risk.

CMBS Update

The CMBS calendar was quiet last week, although there was a good deal of bid list activity. There were two derivatives lists late in the week totaling over $60 million and two CMBS lists.

Two CMBS bid lists hit the screens during last week's trading session. The first was an IO list at totaling $610 million and the second at consisted of $20mln FTST 2000-4TS A2, a triple-A 9.3 year WAL class and $6.4mln CMAT 1999-C2 C, a single- A 12.4 year WAL class.

There will be a very large single-asset transaction coming to market soon with a Rockefeller Center property as collateral, sources said.

Two issues, totaling $872.2 million, are expected for the week of Jan. 15, 2001. There will be a $350 million Gas Company Tower transaction and a $477.2 million Commercial Mortgage Lease-Backed Securities net lease deal (see CMBS pipeline, page 35).

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